FinCEN Files: What Community Banks Should Know

Big banks processed transactions on the behalf of Ponzi schemes, businesses accused of money laundering and a family of an individual for whom Interpol had issued a notice for his arrest — all while diligently filing suspicious activity reports, or SARs.

That’s the findings from a cache of 2,000 leaked SARs filed by banks such as JPMorgan Chase & Co, Bank of America Corp., Citibank and American Express Co. to the U.S. Treasury Department’s Financial Crimes Enforcement Network, or FinCEN. These files, which media outlets dubbed the “FinCEN Files,” encompassed more than $2 trillion in transactions between 1999 and 2017.

Community banks, which are also required to file SARs as part of Bank Secrecy Act/anti-money laundering laws, may think they are exempt from the scrutiny and revelations applied to the biggest banks in the FinCEN Files. Not so. Bank Director spoke with two attorneys that work with banks on BSA/AML issues for what community banks should take away from the FinCEN Files.

Greater Curiosity
Community banks should exercise curiosity about transaction trends in their own SARs that may add up to a red flag — whether that’s transaction history, circumstances and similarities to other cases that proved nefarious. Banks should ask themselves if these SARs contain details that indicated the bank should’ve done something more, such as not complete the transaction.

“That is probably the biggest go-forward lesson for banks: Make sure that your policies and procedures are such that — when someone is looking at this in hindsight and evaluating whether you should have done something more — you can demonstrate that you had the proper policies and procedures in place to identify when something more needed to be done,” says James Stevens, a partner at Troutman Pepper.

Although it may be obvious, Stevens says banks should be “vigilantly evaluating” transactions not just for whether they merit a SAR, but whether they should be completed at all.

Size Doesn’t Matter
When it comes to BSA/AML risk profiles and capabilities, Stevens says size doesn’t matter. Technology has leveled the playing field for many banks, allowing smaller banks to license and access the capabilities that were once the domain of larger banks. It doesn’t make a difference in a bank’s risk profile; customers are its biggest determinant of a bank’s BSA/AML risk. Higher-risk customers, whether through business line or geography, will pose more risk for a bank, no matter its size.

But banks should know they may always be caught in between serving customers and regulatory activity. Carleton Goss, counsel at Hunton Andrews Kurth, points out that changing state laws mean some financial institutions can serve cannabis businesses that are legal in the state but still need to file SARs at the federal level. Banks may even find themselves being asked by law enforcement agencies to keep a suspicious account open to facilitate greater monitoring and reporting.

“There’s definitely a tension between serving customers and preventing criminal activity,” he says. “You don’t always know the extent of the activities that you’ve reported — the way the SAR reporting obligation is worded, you don’t even have to be definitively sure that a crime has occurred.”

“Front Page of the Newspaper” Test
Reporting in recent years continues to cast a spotlight on BSA/AML laws. Before the FinCEN Files, there was the 2016 Panama Papers. Stevens says that while banks have assumed that SARs would remain confidential and posed only legal or compliance risk, they should still be sensitive to the potential reputational risks of doing business with certain customers — even if the transactions they complete for them are technically compliant with existing law.

Like everything else we do, you have to be prepared for it to be on the front page of the newspaper,” he says.

Media reports mean that regulatory pressure and public outrage could continue to build, which could heighten regulatory expectations.

“Whenever you see a large event like the FinCEN files, there tends to be pressure on the regulators to ‘up their game’ to avoid giving people the perception that they were somehow asleep at the wheel or missed something,” Goss says. “It would be fair for the industry to expect a little bit more scrutiny than they otherwise would on their next BSA exam.”

Four Takeaways from One of the Biggest Events in Banking

One of the marquee events in banking has concluded, and what promises to be an interesting and important year for many institutions is underway.

More than 1,300 attendees, including 800-plus bankers, assembled in Phoenix for Bank Director’s 2020 Acquire or Be Acquired Conference. We heard from investment bankers, attorneys, accountants, fintechs, investors and — yes, other bankers — about the outlook for growth and change in the industry. There was something for everyone.

To that end, I asked my editorial colleagues to share with me their biggest takeaways from the conference. Here’s what we came away with.

 

Mergers Get Political

The discussions I found to be the most surprising were executives’ concerns about political regime change, especially as it relates to their decisions around M&A or remaining independent.

“The elephant in the room is that there are two radicals running for president right now,” says Dory Wiley, CEO of Commerce Street Capital. And it’s not just investment bankers who see risk in the potential political change.

Executives of both Lafayette, Louisiana-based IBERIABANK Corp. and Memphis, Tennessee-based First Horizon National Corp. cited political uncertainty on the horizon in their motivations to combine through a merger of equals, which was announced in November 2019. Daryl Byrd, IBERIA’s current president and CEO, says the $31.7 billion bank saw the potential for political risk evolving into economic risk at a time when competition from the biggest banks for customers and deposits remains high. First Horizon saw emerging regulatory risk if the political tides turned.

“Generally speaking, we like a fair and balanced regulatory environment. We knew with the upcoming election that the regulatory would, at best, stay the same, but that it could get worse. So that was a consideration,” says BJ Losch, CFO at $43.3 billion First Horizon.

The mention of these concerns — and the magnitude of the response — has interesting implications. Banks operate in all types of environments, and many elements are outside of executives’ control. The industry has demonstrated resilience and flexibility before, during and after the financial crisis. What are the remaining 5,000-plus banks supposed to do in the face of the impending presidential election?

Kiah Lau Haslett, managing editor

 

Tipping the Scales

The most remarkable observation I had is how important scale has become in the banking industry. It was clear from comments at the conference that the large banks have been taking deposit market share away from the smaller banks, and that is partly a function of size and partly a function of technology. But the two seem to be inexorably connected — it’s the scale that allows those big banks to afford the technology that enables them to dominate the national deposit market.

The recent flurry of MOEs seem inspired partially by the perceived need to create enough scale to afford the technology investments needed to compete in the future. There also seems to be evidence that large banks have become more profitable than smaller banks (although I’m waiting for Bank Director’s 2020 Bank Performance Scorecard to confirm that), and that advantage may be in part because they have become more efficient and driven down costs. JPMorgan Chase & Co. had an overhead ratio (which is basically the same thing as an efficiency ratio) of 55% in 2019, down from 57% in 2018 — that’s better than many banks a 10th of its size. And I bet they continue to drive that ratio even lower in the years ahead because they know they have to.

We may be entering the Era of Big Banks, driven by scale, MOEs and technology. It will be interesting to watch.

Jack Milligan, editor in chief

 

The Attributes of a Trusted Partner

A growing number of technology companies have been founded to serve the banking industry. Not all of them have what it takes to satisfy bankers. What specific attributes is a bank looking for in a partner?

This was the question that inspired a session featuring Erin Simpson, EVP and chief risk officer of Little Rock, Arkansas-based Encore Bank, and Ronny Chapman, president of Compliance Systems.

One of the most important attributes, according to Simpson, is financial sustainability. A bank doesn’t want a partner that may or may not be around in a year or two. Flexibility and configurability are also desirable. “We want partners that will work with us,” says Simpson. “We want partners that are willing to tailor their solutions to our needs.”

A comprehensive product offering is another attribute identified by Simpson. As is the proven viability of products. “We don’t want to be your beta bank,” she says of the $247 million institution. “We don’t want you to be testing your products on us. We want a partner that knows more than we do.”

In short, given the growing role of technology in banking, articulating a defined list of desirable attributes for third-party tech vendors seems like a valuable exercise.

John J. Maxfield, executive editor

 

Learning the Language

“We have to be agile. We have to be nimble.”

That insight was shared by Brent Beardall, the CEO of $16.4 billion asset Washington Federal in Seattle, on the main stage during Day 2.

Since the financial crisis, Beardall has transformed his bank from tech-phobic to more tech-centric. And his thoughts sum up the strategic imperative faced by banks seeking to survive and thrive in today’s challenging marketplace.

In response, boards and executive teams need to learn to speak the language. Technology is no longer an issue that can be delegated to the IT department; it impacts the entire bank.

Talent is needed to drive these strategies forward. Presenters in a session on artificial intelligence asked attendees, how many banks have a chief digital officer? Data scientists? Few bankers raised their hands, identifying a talent gap that aligns with the results of Bank Director’s 2019 Technology Survey.

And change promises to be a constant. “If we go back five years and look back to what we thought this point in time will look like, we would’ve been so wrong,” said Frank Sorrentino III in another panel discussion. Sorrentino is CEO of ConnectOne Bancorp, a $6.2 billion asset bank based in Englewood Cliffs, New Jersey. “The future is still being written.”

Emily McCormick, vice president of research

The Big Banks Are Back


banks-1-28-19.pngIs it now a big bank world that the rest of the industry is just living in?

One could justifiably come to that conclusion based on comments by Tom Michaud, president and chief executive officer at the investment bank Keefe Bruyette & Woods during a presentation on the opening day of Bank Director’s Acquire or Be Acquired conference Sunday in Phoenix.

Approximately 1,300 people are attending the 25th anniversary of Bank Director’s Acquire or Be Acquired event at the JW Marriott Phoenix Desert Ridge resort, which will run through Tuesday.

It’s no secret the four largest U.S. banks—JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup—hold dominant positions in the country’s banking market. These four megabanks control approximately 45 percent of the U.S. deposits. But historically, large institutions have been less profitable than much smaller ones in part because their size and complexity have made them more difficult to manage.

That is now changing, according to Michaud.

Bank of America, for example, posted a return on tangible common equity (ROTCE) in 2017 of 10.8 percent. The bank’s ROTCE rose to 15.4 percent in 2018 and is projected to hit 15.9 and 16.5 percent in 2019 and 2020, respectively.

Similar ROTCE increases are forecasted for JPMorgan, Wells and Citi through 2020.

The reason these banks are now operating at a much higher level of profitability is in part because their management teams have figured out how to turn their enormous size into an advantage. Although analysts, consultants and the banks themselves have often touted the advantage of size, it has had an averaging effect on their financial performance as they have grown increasingly larger in recent years.

“It seems now that the scale argument has a lot more traction,” said Michaud.

Just three years ago, the most profitable U.S. banks based on their performance metrics were in the $5 billion to $10 billion asset category—just large enough to gain some benefits from scale but still small enough to escape the averaging effect. This so-called “sweet spot” shifted in 2017 to banks with assets greater than $40 billion, and Michaud expects these large institutions to again claim the sweet spot in 2018 by an even wider margin once the industry’s profitability data are finalized.

One important place large banks have been able to use scale to their advantage is in technology. The U.S. economy is in the midst of a digital revolution, and the banking industry is being forced to embrace digital distribution of consumer products like checking accounts and mortgages. “Consumers really like the digital delivery of retail banking services,” Michaud said.

And it’s the national and super-regional banks that are capturing the greatest share of “switchers”—consumers who are leaving their current bank for another institution that offers a better digital experience. Michaud cited data from the consulting firm AT Kearney showing that national banks are capturing about 41 percent of the digital switchers, with super-regionals taking 28 percent. Even direct banks at 11 percent have been gaining a larger share of switchers than regional banks, local banks and credit unions.

The advantage of scale becomes most apparent when you look at the amount of money large banks are able to invest to upgrade their digital capabilities. Each of the big four banks are expected to invest a minimum of $3 billion a year over the next few years in technology—and some of them will invest significantly more. For instance, JPMorgan’s annual technology spend is expected to average around $10.8 billion.

While not all of that will be invested in digital distribution, the country’s largest bank is investing heavily to build a digital banking capability capable of penetrating any consumer market anywhere in the country.

New Law Offers Banks a Way to Accelerate Deposit Growth


deposit-8-31-18.pngFor a long time, it seemed as if the deck was stacked against community banks. Since the financial crisis, the nation’s largest banks have gobbled up some $2.4 trillion in new deposits. Big banks have deep pockets to spend on technology—money that smaller banks don’t have. And because of their concerns about safety, customers with more than $250,000 to deposit often shy away from community banks, thinking they are risky places to park deposits given the potential for a bank failure.

But now, some of that imbalance has shifted in favor of community banks. In May, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act. One of many bank-friendly aspects of the new law is a change in treatment of most reciprocal deposits. (Reciprocal deposits are deposits that banks place through a deposit placement network in exchange for matching deposits. Exchanging deposits on a dollar-for-dollar basis via a deposit placement network enables participating banks to provide their customers with access to FDIC insurance beyond $250,000.) Subject to certain restrictions, most reciprocal deposits are now considered nonbrokered. In enacting this change, Congress and the president have essentially acknowledged that most reciprocal deposits tend to behave like other deposits that come from locally based customers, and therefore, are a more stable source of funds than traditional brokered deposits.

Thanks to the new law, a well-capitalized bank with a CAMELS rating of 1 or 2 can hold reciprocal deposits up to the lesser of 20 percent of its total liabilities, or $5 billion, without those deposits being treated as brokered. (Reciprocal deposits over these amounts are treated as brokered.) Further, a bank that drops below well-capitalized status no longer requires a waiver from the Federal Deposit Insurance Corp. to continue accepting reciprocal deposits so long as it does not receive an amount of reciprocal deposits that causes its reciprocal deposits to exceed a previous four-quarter average.

The change in classification is pivotal for many banks. Here’s why:

  • Banks can seek out more large-dollar, safety-conscious customers—business they may not have attracted before, particularly if they’re a smaller community bank competing with a bank that is perceived as “too-big-to-fail.” Many business and nonprofit customers fall into this bucket.
  • Additionally, community banks can pursue more government and financial institution deposits as the nation’s largest banks—which are subject to liquidity coverage ratio calculations—look to shed these deposits. This will provide an opening for community banks to win these large-dollar deposits and to go after the whole banking relationship.
  • But that’s not all. Banks can also do more to replace or reduce their reliance on:
    • Collateralized deposits, which can be associated with significant opportunity costs, since they require banks to invest funds in U.S. Treasuries or other securities that might otherwise be used to fund loans that generate higher returns, and require additional cash outlays for such things as tracking securities.
    • Deposits that come through internet listing services. Such deposits don’t build franchise value the way reciprocal deposits do, and they tend to come from more rate-sensitive customers, not to mention out-of-state or out-of-market customers—who tend to be less loyal.
    • Higher-priced wholesale funding.
  • Finally, community banks can use reciprocal deposits to lock in more low-cost funding as a hedge against higher rates in the future—to take advantage of low deposit betas for services like Insured Cash Sweep® and CDARS®, and to secure customers for longer terms through, for example, a CD offering like CDARS.

Each of these can have a significant, positive impact on the bottom line and on return-on-assets and return-on-equity ratios. And each of these is something that banks can do more of now. Bottom line: With the new law, reciprocal deposits have become even more attractive for well-capitalized banks to use so that they can have more funds on hand and can make more loans.

Funding may still be a challenge for community banks in an environment of increased deposit competition. But thanks to the new law, community banks will at least have greater access to a tool to that can make their jobs easier.

New Big Bank Digital Ventures Could Threaten Community Banks


big-banks-8-14-18.pngAs if community banks don’t have enough to worry about, along comes Finn. And Access. And in the not-too-distant future, Greenhouse. All three are new digital banking platforms that have been introduced or are being test run by some of the country’s largest banks—JPMorgan Chase & Co., Citizens Financial Group and Wells Fargo & Co., respectively—and they mark a significant escalation in the digital banking space, with more new entrants to come. For example, Citigroup—at $1.9 trillion in assets, the country’s third largest bank—announced in late March that it plans going nationwide with a new mobile banking platform, although it hasn’t disclosed an exact release date.

The digital banking space is already crowded with countless fintech neobanks that work with bank partners behind the scenes to offer banking services along with unique personal financial management capabilities to millennials and other digitally-savvy consumers. Included in the mix are somewhat older challenger banks, like Simple, which is owned by BBVA Compass Bancshares (which is itself owned by Spanish banking conglomerate Banco Bilbao Vizcaya Argentaria); well-established direct banks like Bank of Internet USA, a subsidiary of $10 billion asset BOFI Holdings, which started operations in 1999; and unique players like Marcus, a digital platform launched in 2016 by investment bank Goldman Sachs, which combines an automated consumer loan capability with various deposit products—all aimed at a lower-brow customer base than Goldman has traditionally focused on.

“There is not a single incumbent bank in the U.S. with more than 20 branches who would surprise me if they launched a digital subsidiary,” says Peter Wannemacher, an analyst at Forrester Research who focuses on digital strategy in the financial services space. “What I mean by that is, I think every bank in America is considering this option.”

Why so much activity now when digital banking—including mobile—isn’t exactly new? “Incumbent banks are under a lot of pressure,” Wannemacher says. “Some of that’s market pressure. A lot of it is internal pressure. That is, their boards or their C-level executives desperately want to be relevant and be talked about in the digital space.”

Finn, which is branded as “Finn by Chase,” was launched nationwide by JPMorgan Chase (the largest U.S. bank with $2.5 trillion in assets) in June of this year as an all-mobile bank that is separate and distinct from its existing consumer banking product set, including its branch, online and mobile banking distribution channels. Finn includes a checking account with a debit card, a savings account, remote deposit and a multi-featured financial management tool set. Melissa Feldsher, a managing director who heads up the Finn operation, says that Chase is responding to what its research showed was “an unmet need” by a “smaller growing portion of the country that was truly looking for an end-to-end mobile banking experience.” Feldsher says that Finn is specifically targeting all “digitally savvy” consumers rather than just millennials, although she adds that those individuals “will tend to skew younger.”

Wells Fargo, the third largest U.S. bank with $1.9 trillion assets, is developing its own standalone mobile banking app, called Greenhouse. “Greenhouse is currently in a limited customer and team member pilot, and will expand to several states for iPhone users later this year on the Apple App store,” a spokesperson wrote in an email. “We will determine the national rollout following the pilot.” According to published reports, Greenhouse offers a spending account for paying bills, a savings account, debit card and financial management tools. Like Finn, this is a separate offering than what Wells customers receive through its consumer bank.

Taking a somewhat different approach is $155 billion asset Citizens Financial, the country’s 13th largest bank, which in July launched Citizens Access, described as a “nationwide direct-to-consumer digital bank” that will operate separately from its branch operation. Unlike Finn and Greenhouse, Access will only offer savings accounts and certificates of deposit. Citizens Access President John Rosenfeld says direct bank deposits are growing three to five times faster than brick-and-mortar deposits nationally. “This is an opportunity to extend our footprint [so] we can now reach all 50 states,” he says, “whereas we couldn’t do that before with our branch-based web product,” which Rosenfeld says was only available in Citizen’s traditional market. “We didn’t have the capability to open accounts outside the states we were in. Now we do,” he adds.

As large banks target consumers nationwide with these new direct banking ventures, community banks will be under pressure to up their game. “The larger banks are investing more in digital capabilities … and I think that community banks, to compete, are going to have to really evolve their digital capabilities,” Rosenfeld says.

Do the Regulators Want Bigger Banks?


big-banks-12-2-16.pngOne of the more intriguing story lines of the banking industry’s consolidation since the financial crisis is the persistent belief that federal regulators privately want a more concentrated industry with fewer banks because it would be easier for them to supervise, and they signal their support for this laissez-faire policy every time they approve an acquisition.

Consider this comment from a respondent to our 2017 Bank M&A Survey: “Regulators are actively trying to reduce the number of charters, to reduce their workload and to give them control, with fewer institutions to supervise. While they do not openly admit it, every agency has admitted to me that they would prefer fewer institutions. This will cause more consolidation.” Implicit in this perception is the assumption of regulatory bias against the thousands of small banks that dot the industry landscape. The aforementioned respondent to our survey was a director at a bank with less than $500 million in assets.

Are the regulators really guiding the industry’s consolidation with a hidden hand? Looking back to the mid-1980s, I think it’s impossible to argue that the last five presidents and 11 secretaries of the Treasury (not to mention numerous federal regulators) were opposed to the idea of consolidation as the industry shrunk from 14,884 insured institutions in 1984 to 6,058 as of June 2016, according to the Federal Deposit Insurance Corp. The most intense period of consolidation was probably a 20-year period, beginning in 1984, where the industry shrank to just 7,842 insured institutions by the end of 2003—nearly a 50 percent reduction!

I found this observation in a 2005 article in FDIC Banking Review, entitled “Consolidation in the U.S. Banking Industry: Is the Long, Strange Trip About to End?” “Over the two decades 1984 to 2003, the structure of the U.S. banking industry indeed underwent an almost unprecedented transformation—one marked by a substantial decline in the number of commercial banks and savings institutions and by a growing concentration of industry assets among a few dozen extremely large financial institutions. This is not news.” And if it wasn’t news in 2005, it certainly shouldn’t be news today.

I think a more interesting question is whether the collective governmental brainpower seriously considered the systemic ramifications of a more concentrated industry—especially the creation of megabanks like JPMorgan Chase & Co., Wells Fargo & Co. and Bank of America Corp. Those three institutions, along with Citigroup, rank as the four largest U.S. banks and collectively held 40 percent of the industry’s total deposits and 42 percent of its total assets as of September 2016, according to S&P Global Market Intelligence.

It was the fear that a large bank would fail during the financial crisis, worsening the situation even further, that led to the controversial and much criticized industry bailout and provided the emotional fuel in Congress to pass the Dodd-Frank Act. Even today, approximately seven years after the crisis passed, we are still debating whether another unofficial governmental policy from years past—too big to fail—could be deployed in times of emergency despite the efforts of the framers of Dodd-Frank to kill it once and for all. I would say that Washington ended up getting exactly what it had wanted over the last three decades—a more concentrated industry with fewer banks—but doesn’t seem to be very comfortable with the outcome.

Another interesting question is when will consolidation end? It’s taken as gospel that the four megabanks will not be allowed to do any more acquisitions because they’re already too large, and most of the M&A activity in recent years has been in the community bank sector, where individual banks do not pose a systemic threat to the economy. But is there a number at which point the regulators, Congress or some future presidential administration would say enough? A more concentrated industry poses systemic risks of its own, so does Washington reverse its laissez-faire policy when we reach 5,000 banks, or 3,500, or even 2,000?

If anyone in Washington has an answer to that question, I’d love to hear it. Then again, President-Elect Trump fits the description of a laissez-faire capitalist as well as anyone, so maybe he’ll let the banking industry seek its own final number.

Bank Compensation and Wells Fargo: The End of an Era


compensation-10-21-16.pngOne of the biggest scandals among big banks in years is still unfolding as Bank Director heads into its annual Bank Executive and Board Compensation Conference Oct. 25 to Oct. 26 on Amelia Island, Florida. Wells Fargo & Co. announced last week the immediate retirement of CEO John Stumpf, with Chief Operating Officer Tim Sloan taking on the CEO job, as the board struggled to deal with public outrage over accusations that the bank’s employees had opened more than two million fraudulent accounts on behalf of customers to game aggressive sales goals.

The case raised questions about compensation and governance at the most basic level: What impact did the bank’s incentive package have on employee behavior, if any? What impact did the bank’s sales culture and sales goals have on the behavior of employees? What did the bank’s management know about fraudulent account openings and what did it do to stop it? If management failed to stop the fraudulent activity and benefited financially from it, should compensation be adjusted for those individuals, and if so, by how much?

These are all issues of extreme importance to Wells Fargo’s board, whose independent members are conducting an investigation, but also, to any board. No one wants to have a scandal of this magnitude take place while they serve on a board. If employees are complaining about bad behavior and bad culture, how does your bank handle it? How are you ensuring that complaint patterns from employees and customers are recognized and reported to upper management? Should the board also get these reports? What types of behavior are your incentives and sales goals motivating?

Wells Fargo’s board and now, Tim Sloan, are in the unenviable position of having to change the bank’s consumer banking culture even as they try to assess what went wrong. The pressure is strong to show the public and government officials that it is taking action quickly. Wells Fargo has said that as of Oct. 1, it had ceased all sales goals for branch-level employees and instead will start a new incentive program based on metrics related to customer service and risk management.

Since the sales culture had been very much a part of Wells Fargo’s identity, and higher than average profitability, investors are wondering how this will impact the bank’s financial performance. Keefe, Bruyette & Woods analysts Brian Kleinhanzl and Michael Brown downgraded the stock to market perform and wrote last Friday that “Wells’ management doesn’t know what the consumer bank will look like in the future.”

The stock price has fallen to $45 per share as of Wednesday afternoon from $50 per share at the start of September, before the announcement of a $185 million settlement over the issue with regulators and Los Angeles officials, who had sued the company. Is this the end of an era for Wells Fargo? I think so, as major changes will need to be made.

Community bankers tend to point to scandals like this as a way to differentiate themselves from the big banks. Many of the community banks I know don’t have an aggressive sales culture, let alone sales quotas. It’s also easier to know what’s going on in a small bank than one with more than $1 trillion in assets. Still, many bank boards in the wake of the scandal may be asking questions about their own sales culture, their incentive packages and compliance with company policies and ethical standards. Regulators are certainly asking these types of questions of banks, and I expect this to continue in the wake of the scandal. For more on the topic of culture, and determining your bank’s culture, see Bank Director magazine’s fourth quarter 2015 issue.

When we talk about compensation, we may talk about salaries, stock grants, deferrals and clawbacks. But what we’re really talking about is how to motivate employees to do a good job for the bank. And if you don’t have the culture to match what’s good for the bank and your shareholders, you don’t have much.

Banks and Fintechs Adjust Strategies as Sector Matures


strategy.png

After a period of rapid growth, the fintech sector has reached, if not full maturity, at least the end of its adolescence. With customer acquisition growth rates slowing among digital wealth management services, otherwise known as robo-advisors, a number of industry participants have adjusted their strategies in response. One development reflecting this process is the increasing tendency among large banks and other financial institutions (FIs) to enter the sector by purchasing some of the earliest and most successful innovators in the field.

This marks a change from the approach more commonly seen early in the fintech revolution, when large FIs were more likely to take positions as minority shareholders in promising fintechs than to buy them out. Fintech buyouts hit an all-time high in 2015 as banks rushed to stake their claim in this disruptive market, with KPMG and CB Insights showing fintech investments growing from $3 billion in 2011 to $19 billion in 2015. A CNBC.com report on the sector sees no signs of this trend abating in 2016, with big banks expected to continue to favor outright purchases of technology innovators in the sector over investing in startups.

Other banks and FIs have chosen to pursue different strategies, either forming partnerships with leading fintech firms or, in the case of some of the largest FIs such as Fidelity and Schwab, electing to build their own digital wealth management platforms. Fintech firms, in the meantime, continue to rely on product innovation to attempt to set themselves apart from their competitors. As sector growth moderates and truly disruptive innovations become more difficult (and expensive) to develop, these startups must make difficult decisions about whether to attempt to go it alone or to merge or partner with existing financial industry players.

Outside of a few companies willing to devote the tremendous resources necessary to build their own platforms, the majority of FIs entering the fintech space have done so via purchases or partnerships. While partnerships can be a viable method for entering the sector, some banks and other FIs prefer to own the technology their customers use to access their financial information. For these firms, purchasing an existing fintech company offers the advantage of speeding time to market and gaining the expertise of the tech-savvy founders or operators of the acquisition, in addition to controlling the use and development of the acquired technology.

In an interview for this article, Charlie Haims, vice president of marketing at cloud-based portfolio management service MyVest, expanded on this idea: “The larger FIs historically choose to build a new innovation in-house to tightly integrate it with the rest of the company. But now we are seeing an increase in acquisitions, like BBVA with Holvi, Groupe BPCE with Fidor, Silicon Valley Bank with Standard Treasury and many in wealth management like BlackRock with FutureAdvisor, Invesco with JemStep, and Northwestern Mutual with LearnVest.” Haims attributes this trend to sizable VC investment in fintech startups a few years back, leading to the recent buyouts of VC-backed startups whose success in the field attracted suitors.

While owning your own fintech platform may seem attractive to banks and other FIs looking to enter the space, the truth is that the cost of this approach, whether via purchasing an existing startup or building your own platform, is by no means trivial. A price tag upwards of $100 million to build a comprehensive digital wealth management platform is not unknown. For many banks interested in entering the field, finding a technology partner is perhaps a more practical way of gaining access to the industry. Haims agrees: “For smaller FIs, the best approach is often partnering with leading service providers or startups to quickly adopt the best-of-breed for a given fintech innovation, and this still seems to be the case today.”

MyVest offers its enterprise wealth management software platform to FIs such as banks, broker-dealers, RIAs and service providers. Haims cites banks as being particularly well-suited to use the company’s service to “help them bridge silos across their trust, brokerage and RIA divisions, so they can run a smoother operation and provide a holistic customer experience on a single, unified platform.” The company also has channel partnerships with Genpact Open Wealth and Thomson Reuters Wealth Management “to offer a combination of wealth management technology and services to FIs.”

In addition to digital wealth management, banks have formed partnerships across a variety of other fintech platforms, including startups in the crowdfunding and direct-to-consumer loan sectors. In the former category, BNP Paribas has inked a partnership deal with SmartAngels, which provides a platform for investing in crowdfunding deals; in the latter category is JPMorgan Chase’s partnership with On Deck Capital, which provides online small business loans.

As the industry matures, the competition among fintech sector participants has become increasingly fierce. In the digital wealth management field, independent robo-advisors now face the challenge of competing with large FIs such as Vanguard and Schwab, which have attracted the bulk of new robo-advisor assets since entering the space.

One prominent robo-advisor, Personal Capital, has engaged a private equity firm to help it consider its financial options, leading some to speculate that the firm is seeking a buyer. Other digital wealth management platforms, such as Wealthfront and Betterment, have stressed their dedication to innovation as a major factor in helping them stay competitive. Industry expert Craig Iskowitz has outlined the challenges facing such firms as their growth slows in an article on his Wealth Management Today blog. In the article he suggests that, rather than going head-to-head with industry behemoths for assets, a hybrid model of “selling to consumers as well as advisors, along with the B2B model, will soon be seen as the best way to succeed in this market.”

Among digital wealth management advisory services continuing to pursue the direct-to-consumer model, Iskowitz cites the Acorns robo-advisor platform as notable for experiencing robust growth by pursuing a millennial-friendly strategy. The company’s mobile app allows users to link their bank or credit card accounts to the firm’s platform and automatically invest the spare change gained from rounding up transactions to the nearest dollar in an electronically traded fund, or ETF, which is a diversified portfolio of securities that can be valued and traded at any time during the trading day instead of after market close like a mutual fund.